NN IP: A rosy outlook for Asian fixed income in 2020

February 13, 2020

• We have a favourable outlook for Asian credit markets this year, particularly Asian high yield and Singapore dollar-denominated bonds
• The economic impact of the coronavirus is likely to be temporary in nature but investor sentiment could remain volatile
• ESG integration in the region continues to flourish as investors increasingly prioritise sustainability

We expect Asia’s fixed income markets to benefit from supportive investor sentiment as underlying economic growth in the region stabilises in 2020 after a strong showing in 2019. Developments that could shake up market sentiment this year include the US presidential elections, the conclusion of Brexit and ongoing trade-related disputes. The ongoing Wuhan coronavirus crisis has also prompted significant investor concern regarding Chinese demand in the first quarter of this year. Although these events have the potential to elevate volatility in financial markets, credit markets still look attractive as risk appetite is likely to be supported by global liquidity. ESG integration is also expected to continue flourishing in Asia as investors increasingly prioritise sustainability.

A favourable outlook for Asian credit

We have a favourable overall outlook for Asian credit on the back of improving economic conditions and attractive valuations. The improvement in economic conditions will be based on relatively strong economic growth in Asia, when compared with, for example, developed markets. Several markets in Asia have the ability to boost economic growth by adopting further accommodative monetary policy, as inflation is benign in most markets.

Economic growth in China will continue its managed path downward as the economy transitions to a services-driven model. We also need to pencil in an additional slowdown due to the impact of the coronavirus on economic activity, as well as potential ongoing trade tensions. On the other side of the coin, the Chinese government is expected to provide support through fiscal measures as well as accommodative monetary policy.

Our outlook for Asian high-yield bonds is particularly favourable, as they will benefit from a stronger technical environment as supply normalises after a heavy 2019 pipeline. Meanwhile, we anticipate further inflows to Asia as the search for yield continues across emerging markets amid the massive amount of negative-yielding assets in developed markets.

‘Asian high yield bonds will benefit from a stronger technical environment as supply normalises after a heavy 2019 pipeline.’

On valuations, spreads for Asian high-yield bonds are around double those for similarly rated U.S. high-yield bonds. They also tend to have a shorter duration than their US counterparts, resulting in lower interest-rate risk. This market has grown quickly in recent years, with the value of the Asian high-yield bond universe (as defined by the high-yield rated bonds in the JP Morgan Asia Credit Index, or JACI) at over USD 190 billion as at end-2019. The asset class looks suitable for investors with a higher risk appetite and those who are prepared to invest for the medium to long term.

Among Asian high-yield bond issuers, we favour Chinese property companies. The supply and demand picture for Chinese property bonds looks healthy at present, while average sales price and volumes are also supportive of the sector. While onshore liquidity remains tight, property companies have relatively better access to funding and they can sell part of their land bank or projects if funding becomes challenging, leading to a lower risk of defaults.

For investors who are less keen on volatility, high-quality Singapore dollar-denominated corporate bonds are another attractive option, offering relatively good yield relative to US dollar bonds. Medium-tenor Singapore dollar rates have declined by less than half of the drop in US Treasury rates in 2019, offering a better entry point for the Singapore dollar bonds. This asset class also benefits from relatively lower supply and high investor demand, keeping technicals supportive.

Impact of the coronavirus

We expect the news related to the coronavirus to deteriorate before the situation is brought under control. The virus will likely have a short-term impact on economic activity. The 2002/2003 SARS outbreak suggests that the services sector will be hit the hardest. The importance of China’s services sector has increased over the years and its current share of GDP is 53%. The sectors expected to be affected most significantly are transportation, hotel and catering services and Macau’s gambling industry. In addition to the services sector, industrial production may be affected as factories in most provinces extended closure of plants following the Lunar New Year break.

In a scenario of a short-term impact, economic activity will be negatively impacted in the first quarter of 2020. Investor sentiment for Asian asset classes will be affected by further news flow on how the virus can be controlled/cured and how strongly the Chinese government will respond. The strong measures taken by the Chinese government might be harmful to economic activity as various companies, factories and construction sites are closed for a two-week period to prevent the virus from spreading further. Our analysis shows that the companies in our universe are not materially affected by a two-week shutdown, but the risk is that the Chinese government might lengthen this period to get the situation under control.

The fundamental impact of the virus on issuers in the Asian USD universe looks manageable in our base-case scenario, in which the situation is brought under control within the next couple of months. In that scenario, the economic impact will be limited and only a relatively small number of issuers in the Asian USD universe will be directly affected. Therefore, we don’t expect panic selling of Asian USD bonds, but investor sentiment could remain volatile in the coming weeks.

ESG integration continues to flourish

The use of environmental, social and governance (ESG) criteria continues to gain prominence for global investors, including those in Asia. This is backed by the findings of NN IP’s recent Responsible Investing survey, which showed that 49% of professional investors plan to improve their responsible investing approach for fixed income. Moreover, investors increasingly demand a premium for investing in companies that lack transparent ESG policies, as reputational issues arising from unethical practices can inflict financial damage.

We have a strong conviction that ESG integration bolsters risk-adjusted returns. Experience has shown us that investors do not need to sacrifice returns when implementing a thorough ESG analysis. ESG factors therefore play a strong role in our credit assessment approach and are fully integrated into 66% (or USD 194 billion) of our assets under management. ESG integration has been integral to our credit analysts’ assessment of Asian debt investments for several years now. We assess companies by analysing data from external sources, applying sector-specific weights for ESG factors guided by our Responsible Investment team, examining a firm’s policies and practices, and engaging with company management.